Already Gone

Well I heard some people talkin' just the other day
And they said you were gonna put me on a shelf
But let me tell you I got some news for you
And you'll soon find out it's true
And then you'll have to eat your lunch all by yourself

'Cause I'm already gone
And I'm feelin' strong
I will sing this vict'ry song woo hoo hoo woo hoo hoo

-The Eagles


Now that my primary career is likely winding down, I will open things up a bit. This weekend in the Wall Street Journal and in Barron's the quality of bank earnings is discussed. Nothing which is discussed should surprise anyone who has read this publication or paid attention to the fixed income markets. While the equity market and the stock jockeys (and their CNBC instigators) pushed for and then celebrated the modification of mark to market accounting, fixed income market participants knew the real story. They knew where much of first quarter profits were created and what challenges lay ahead for financial institutions.

Many readers have called me on the desk asking my opinion of statements made by certain bank CEOs that January and February were profitable. It pained be to rain on the parades of optimistic and hopeful advisers and investors, but I had to point out that AIG was responsible for fast starts by banks in 2009. AIG was being pushed by its government masters to unwind counterparty agreements and insurance contracts immediately. AIG paid up to do so. This created profits for troubled banks. These profits appeared as profits from capital markets and trading. It is true that financial firms' did earn some impressive profits from trading and underwriting, but AIG had much to do with the good first quarters we are seeing.

Some banks were less transparent than others. One large bank which reported earning last week was downright boastful. Its CEO was bragging how its capital markets division outperformed JP Morgan and Goldman Sachs. This is like the owner of the Kansas City Royals bragging that his team got off to a better start than the Yankees and the Red Sox without acknowledging that his team was the beneficiary of playing week, pitching-deficient opponents. A wise owner would be wise not to compare his team with the leagues elite when it is playing with a thin bench and an over-worked bullpen (as is the aforementioned large bank). Maybe this CEO should explain why his soon-to-be shared wealth management unit was reported by Bloomberg News to have lost $40 billion in client assets which have deserted the bank for other firms. My colleagues and I did some estimating of our own and believe that the figure could be upward of $50 billion. This does not count the loss of some big producing teams which we learned are leaving the firm as of last Friday.

The Barron's article correctly states that it is the Temporary Liquidity Guarantee Program (TLGP) which is the real boon to the banks rather than TARP. The TLGP program enables banks (and banks in name only) to issue bonds with the EXPLICIT guarantee of the U.S. government. This is a stronger guarantee than what is carried by FHLMC and FNMA bonds which are only "effectively" according to FHFA Chairman Lockhart (an effective guarantee is merely an acknowledgement of the implied guarantee which has existed all along). Although provisions were put in place to address the repayment of TARP money, the government never thought (yeah, that's surprising) to address the TLGP bonds. As of now, companies such as JPM (which has the funds) and Goldman Sachs (which has nearly enough funds) can pay back TARP money. However, both companies have issued TLGP bonds with coupons in the low 2.00% area or less. The government was banking on (no pun intended) that banks would be unable or unwilling to pay back TARP funds early. Therefore, the government never thought it would have to address the problem of banks exiting the TARP program yet continuing to benefit from TLGP. In fact, as of right now banks can leave TARP but continue to issue FDIC-guaranteed bonds with maturities as long as December 2012. FDIC chief Sheila Bair had been advocating extending the maximum maturity until 2019. Now word on how she likes her crow prepared ( au vin would be my choice).

The large bank which as been the subject of much media attention since Friday has been criticized for skimping on loan loss reserves. This is not a matter which should be taken lightly (by any bank for that matter). All the data indicates that defaults and delinquencies among mortgages, credit cards, auto loans and lines of credit continue to rise. While the bulls and broker cheerleaders (also known as management) continue to predict a quick economic recovery and push FAs to allocate more client assets to equities, some of us are focused on rising unemployment and its lagging effects. What lagging effects? When workers lose their jobs, they do not always immediately fall behind in their payments. Some have severance pay and nearly all have unemployment benefits. We probably have not seen the full effects of the sharp increase of unemployment in loan defaults and delinquencies. This makes the stress tests very important, if they are not charades or shams.

Properly conducted, the stress tests would reveal the true values of assets held on bank balance sheets, including loans. Loans could be the critical asset class as they are not now, nor have they ever been, subject to mark to market accounting. There could be hidden land mines among the banks. Some have been more transparent than others. Last week, JP Morgan's earnings report included loan writedowns of $700M. Although this may not represent the true extent of balance sheet impairment, the company at least partially acknowledged its problems. No such writedowns were taken by the other, chest-pounding, bank which reported earnings last week. Want to see which banks are relatively healthy and which banks are not. The healthy banks are planning to pay back TARP early. The unhealthy banks boast while they are forced to sell of businesses at the behest of the government.